Great Expectations for Merrill CEO

Investors Put Stock in Thain
To Restore Growth, Profitability

John Thain
has done such a good job stabilizing
Merrill Lynch
& Co. that investors already are betting he can return the Wall Street firm to profitability and growth in the near future.

Despite missing earnings expectations because of another multibillion-dollar write-down that led to the third straight unprofitable quarter, investors drove Merrill shares up 4.1% Thursday, setting a higher bar for Mr. Thain's next act as chief executive.

More on Merrill

People familiar with the firm say investors shouldn't be disappointed when the year is done. The company is optimistic that it will return to profitability in the third and fourth quarters and make money for the year overall. That will be a big change from the miserable performance Merrill has produced since last summer, when the value of its mortgage investments began to plummet.

Merrill posted a $1.96 billion first-quarter loss and is in the process of cutting 4,000 jobs. The brokerage logged $6.6 billion in fresh write-downs in the quarter, and its $2.19-a-share loss was greater than the $1.99-a-share loss expected by analysts polled by Thomson Reuters.

The firm has written down more than $30 billion and offset some of that by raising $12.8 billion in new capital. Now, Mr. Thain has opened the door to raising more capital. In an interview, Mr. Thain said Merrill, still saddled with billions of dollars in hard-to-sell mortgage assets, is considering issuing perpetual preferred shares, like J.P. Morgan Chase & Co. did earlier this week. These shares pay investors a nice yield but don't dilute common shares.

Mr. Thain said no final decision has been made on this. "We are thinking about it, and what happens will depend on market conditions and investor appetite," he said.

That should further calm investors who have concerns about their balance sheet. But getting Merrill's financial house in order could be the easier task. To satisfy investors, Mr. Thain must figure out ways to get Merrill to grow again despite the loss of several key, profitable businesses. Merrill, like other Wall Street banks, also is trying to reduce its dependence on borrowed money, which boosts profit during good times.

"The environment has changed, and we need to return to the basics and remain focused on our clients," Mr. Thain said.

When
Stanley O'Neal
became Merrill chief executive in 2002, the firm was known as "Mother Merrill" because of its high-cost, paternalistic culture. Mr. O'Neal quickly pushed the firm into a number of profitable, albeit risky, areas, many of which fall under the rubric of structured finance, from packaging mortgages to big corporate loans.

Next Step, Profit: Merrill Lynch's chief executive, John Thain.

Over time, he improved the firm's return on its equity, and the stock price soared. His plans were undone by the housing crisis, which has resulted in more than $200 billion in write-downs across Wall Street.

Already it is clear that Mr. Thain plans to refocus the company's attention on its bread-and-butter business of selling stocks and bonds to investors, a division that has taken a back seat in recent years as the firm has pushed into other areas.

Thursday, that division posted record net revenue of $3.6 billion, up 8% from the year-ago period. None of Merrill's 4,000 layoffs, equal to 10% of the firm's work force, will come from this division. When asked by Deutsche Bank AG analyst
Michael Mayo
how long this division will be "protected" from Merrill's current corporate restructuring, Mr. Thain said he sees no reason to reconsider his decision as long as the division continues to post record results.

Cheat Sheet

Later, in an interview, Mr. Thain said global wealth management will be even more critical to Merrill's earnings in the future and that he wants the firm to expand its operations in countries such as India and Brazil. Already the firm has moved to a more fee-based model rather than one based on commissions.

That, he says, will give Merrill a more steady income flow, even in times when customers aren't trading as much.

But it will take more than wealth management to right the ship. Merrill, Mr. Thain says, will do more principal investing, deploying its money in off-balance-sheet third-party investments alongside other investors. It has plowed more than $700 million into a real-estate fund in the Pacific Rim. It has plans to make at least two more big investments, one in Latin America and one in Europe.

Some brokerage firms are hoping to boost profits by raising fees. Earlier this month,
Lehman Brothers Holdings Inc.
increased its merger-and-acquisition fees anywhere from 10% to 71%. In a note to its investment-banking department, senior managers said the move was designed to bring Lehman's fees more in line with fees charged at Goldman Sachs Group Inc. and Morgan Stanley.

See earnings cheat sheets for large tech, health, banking and other companies.

There are other pressures brewing. Merrill now can borrow money from the Federal Reserve, just as commercial banks do. The move by the Fed was designed to prevent another Bear Stearns-like collapse, but in exchange for that privilege, Merrill and others may have to reduce the amount of money they borrow from all sources to fund their operations.

A reduction in the amount of borrowed money they use in their business could potentially lead to lower returns on equity, which means future profits would grow at a slower pace.

Merrill's results include $1.5 billion in write-downs on mortgage-related securities, bringing the total write-downs over the past nine months to more than $18 billion on those securities alone. The bank also took a $925 million write-down on leveraged loans and a $3 billion reserve on hedges with bond insurers.

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